Sunday, November 13, 2022

Everyone's been wrong about inflation, and it's costing workers in salary negotiations

jzinkula@insider.com (Jacob Zinkula) - Markets Insider

Federal Reserve Chair Jerome Powell testifying at a hearing of the Senate banking committee.
 

Inflation eased in October, but it stayed well ahead of most workers' year-over-year pay increases.

Many Americans expected inflation to cool sooner and quicker than it has.

That miscalculation is one of the factors working against them during salary negotiations.


Americans keep waiting for inflation to return to normal levels. But that wait has taken longer than expected, and it could be among the reasons wages have fallen well behind inflation over the past year.

The Consumer Price Index rose 7.7% in October versus a year earlier, the Bureau of Labor Statistics announced Thursday morning. That's a big slowdown from previous months, but it still marks faster price growth than Americans had seen for decades before the coronavirus pandemic.

While American workers are experiencing the strongest wage growth in many years, fueled by strong demand for labor, inflation has continued to overpower pay gains for most workers. Average hourly earnings, for instance, rose 4.7% in October, continuing to trail even the slower inflation rate.

"Wage growth has not been beating inflation. So if anything, wage growth is actually pulling down on inflation," the EPI economist Elise Gould previously told Insider.

Several things have held back workers in their salary negotiations, including the decline of unions, stagnant minimum wages, globalization, and perhaps even some corporate greed. But another key factor could be that American workers and their employers have continued to underestimate how much prices will rise in the future — and therefore how much of a raise workers will need to keep up.

As the economics writer Noah Smith posed in a recent blog post, "If both employers and employees think inflation is going to die down in a couple months, maybe they'll keep getting surprised when inflation fails to die down, with the result that wages keep undershooting inflation."

When prices first began to spike, there was speculation that wages weren't keeping up because most Americans negotiate salary increases only once a year. But now that inflation has been at least 5% for 18 consecutive months, there's been ample time for employers — many of whom have seen rising profits — to raise wages. But wages haven't kept up, and it could partially come down to some people underestimating how big of a raise workers would need.

An October New York Fed paper found that as inflation rose in 2022, Americans' expectations for future price growth "unexpectedly fell." The authors speculated that once "extraordinary circumstances" like the pandemic and the war in Ukraine normalized, many people believed there would be a "sharp fall" in inflation as well.

Even as inflation begins easing, that sharp fall hasn't materialized yet.

For instance, when inflation reached 5% in May 2021, respondents in an ongoing New York Fed survey of roughly 1,300 Americans expected inflation to be 4% a year later. It was 8.6%. In October 2021, respondents projected 5.7% inflation a year later, compared with the 7.7% just reported.

One-year-ahead inflation expectations topped out at 6.8% in June and fell to 5.4% as of September, the lowest level since September 2021.

Perhaps Americans' most recent projections will prove correct. But if their prior miscalculations led them to demand a smaller pay bump than they otherwise might have, they'll ultimately come out behind.


Workers have finally had the power to demand higher wages


Among the key reasons workers have seen their pay rise at all is the ongoing labor shortage. Despite the Federal Reserve's efforts to cool the economy, the unemployment rate remains near a 50-year low, and there are still well over 10 million job openings. Employers in need of workers are generally willing to pay more.

With demand for labor so high, some experts have wondered why Americans' wages haven't grown by even more. For instance, the Fed's concerns about a "wage-price spiral," in which inflation leads workers to demand higher wages leading to more spending and even higher inflation, has yet to come to pass. Wages have continued to lag behind inflation.

One explanation could be, at least in part, widespread expectations that inflation would prove transitory.

As long as the unemployment rate remains low, job openings remain high, and a severe recession is avoided, Americans may still have the leverage to push for the pay they've missed out on. But economic conditions could change on a dime; workers won't be able to capitalize on these conditions forever.


"One of the threats of allowing the unemployment rate to rise is that not only you could have millions of people lose their jobs, but also workers — even who have their jobs — lose some of that leverage to be able to build up their wages, because they're less scarce," the EPI's Gould previously told Insider.

There's evidence companies miscalculated as well when it comes to forecasting inflation.

Insufficient pay is among the reasons workers have joined the Great Resignation in droves over the past few years. Despite the Fed's efforts to cool the labor market, 4.1 million workers called it quits in September, well above pre-pandemic levels. Businesses continuing to grapple with labor shortages, evidenced by the millions of job openings, may have lost fewer employees if they'd simply paid them more. As the economy slows, not every business will be able to support further wage hikes, but if they can, this may be their best option to get these workers back.

While wages not keeping up with inflation is a bad thing for Americans' bank accounts, it could ultimately help ease inflation further in the year ahead. And if this results in the Fed slowing its pace of rate hikes — and a severe recession is avoided — perhaps it will be a fair tradeoff for some workers.

No comments:

Post a Comment